Treasury and Cash Management: formula sheet

Key formulas

Motives for holding cash

Transaction + Precautionary + Speculative (+ Compensating balance, where a bank requires it)

Give a one-line meaning and a business example for each motive.

Core objectives of cash management

Meet payment schedule (liquidity) + Minimise funds locked in cash (cost control)

The two objectives conflict. Say that good management balances both.

Cash management strategies (typical headings)

Cash planning | Managing cash flows | Optimum cash level | Investing surplus cash

Use these as headings when asked for the areas or strategies of cash management. Add detail from your study material.

Net cash flow

Net cash flow = Total cash receipts − Total cash payments

Calculated for each month. Only cash items are included.

Closing cash balance

Closing balance = Opening balance + Total receipts − Total payments

The closing balance of one month is the opening balance of the next.

Surplus or deficit

Surplus or (deficit) = Closing balance before financing − Minimum cash balance

A negative result is the amount to be financed. A positive result can be invested.

Collections from credit sales

Collection in month = Credit sales of the earlier month (shifted back by the credit period) × percentage collected as per the collection pattern

If the credit period is 2 months, sales of January are collected in March. Apply discounts and bad debts if given.

Payment for credit purchases

Payment in month = Purchases of the earlier month according to the credit period

A one-month credit period means March payment is for February purchases.

Baumol optimal cash conversion size

C = √(2 × U × P ÷ S)

U = total cash needed in the period, P = fixed cost per transaction, S = opportunity cost per rupee for the same period (annual rate for annual U).

Baumol total cost

Total cost = (C ÷ 2) × S + (U ÷ C) × P

First term is holding (opportunity) cost on average cash C ÷ 2. Second term is transaction cost. At the optimum, the two terms are equal.

Number of transactions and average cash

Number of transactions = U ÷ C; Average cash balance = C ÷ 2

Use the optimal C. The period of the interest rate must match the period of U.

Miller-Orr spread

Spread = 3 × [ (3 ÷ 4) × b × σ² ÷ i ] ^ (1/3)

b = cost per transaction, σ² = variance of daily net cash flows, i = interest rate per day. If standard deviation is given, square it first. Take the cube root of the bracket.

Miller-Orr limits

Upper limit = Lower limit + Spread; Return point = Lower limit + Spread ÷ 3

The lower limit is given by management. Return point is one-third of the spread above the lower limit.

Miller-Orr average cash balance

Average cash balance = Lower limit + (4 ÷ 9) × Spread

This is the form commonly used in ICAI-style numericals.

Miller-Orr action rule

At upper limit: buy securities worth (Upper − Return point). At lower limit: sell securities worth (Return point − Lower).

Between the limits, no transaction is made.

Collection float

Collection float = Mail float + Processing float + Clearing float

All in days. Lock box mainly cuts mail and processing; concentration banking cuts mail and clearing.

Cash released by faster collection

Cash released = Average daily collections × Days saved

Average daily collections = Annual collections ÷ 365 (or 360 if the question says so).

Annual return on released cash

Annual benefit = Cash released × Rate of return

Use the opportunity rate given, such as the investment or borrowing rate.

Net benefit of a scheme

Net benefit = Annual benefit − Annual cost of scheme

Accept the scheme only if net benefit is positive.

Net float

Net float = Disbursement float − Collection float, equivalently Bank balance − Book balance

Net float is positive when uncleared issued cheques make the bank balance exceed the book balance.

Cost per rupee freed

Cost per ₹ released = Annual cost ÷ Cash released

Compare this with the rate of return. Accept if the return rate is higher.

Discount instrument yield (simple, annualised)

Yield = [(Face value − Purchase price) ÷ Purchase price] × (365 ÷ Days to maturity) × 100

Use for T-bills, CP and CDs sold at a discount. Divide by purchase price, not face value. Use 365 days unless the question says 360.

Purchase price of a discount instrument

Price = Face value ÷ [1 + (Yield × Days ÷ 365)]

Yield is in decimal form. Use when the question gives the required yield and asks for the price.

Holding period return

Holding period return = (Maturity or sale value − Cost + Income received) ÷ Cost × 100

Not annualised. Convert to an annual figure only if the question asks.

Selection criteria

Safety, Liquidity, Maturity, Yield

Remember these four. Add tax and diversification if the question is descriptive.

Quick revision

• Treasury management covers cash, funding, investment, risk and relationships with banks and investors.
• The three classic motives for holding cash are transactions, precautionary and speculative.
• Cash management aims to meet payments on time while keeping idle cash low.
• A cash budget shows receipts, payments and closing balance period by period. Non-cash items such as depreciation are excluded.
• Cash budget closing balance = opening balance + receipts − payments. Compare it with the minimum cash balance to find surplus or deficit.
• Baumol model: optimal conversion C = √(2 × T × F ÷ H), where T is total cash need, F is the cost per transaction and H is the holding cost rate.
• Baumol assumes steady cash use and no cash receipts during the period.
• Miller-Orr model suits uncertain cash flows. It sets a lower limit, a return point and an upper limit.
• In Miller-Orr, upper limit = lower limit + spread, and return point = lower limit + spread ÷ 3, where spread = 3 × [(3 × transaction cost × variance of daily cash flows) ÷ (4 × daily interest rate)]^(1/3).
• Float is the time gap between a payer initiating a payment (for example, issuing a cheque) and the payee getting usable funds. It has three parts: mail float (time the cheque is in transit), processing float (time the payee takes to record and deposit it) and clearing float (time the banks take to clear it). Collection float delays your receipts.
• Speed up collections with lockbox and concentration banking. Slow down payments only within ethical and contractual limits.
• Money market instruments include treasury bills, commercial paper, certificates of deposit and call money. Match each to its issuer and tenor.

Common mistakes

• Treating treasury management and financial management as the same thing. Fix: Say financial management covers investment, financing and dividend decisions for shareholder wealth. Treasury is the narrower function that manages cash, funds, surplus investment and financial risk.
• Writing only cash management and ignoring other functions. Fix: Cover funding, investment of surplus, banking relations, forex and risk management and reporting as well.
• Mixing up precautionary and speculative motives. Fix: Precautionary is for bad surprises (a shortfall). Speculative is for good surprises (an opportunity). Ask whether the surprise hurts or helps.
• Writing definitions without examples. Fix: Add one practical example per motive, such as wages for transaction, delayed collection for precautionary, a raw material price drop for speculative.
• Including depreciation or provisions as a cash payment Fix: Ask whether money leaves the bank in that month. Depreciation, bad debts written off and provisions do not.
• Showing sales in the month of sale when they are credit sales Fix: Shift credit sales forward by the credit period. Only cash sales are received in the month of sale.
• Using an annual interest rate in the Miller-Orr formula. Fix: Miller-Orr needs the interest rate per day because σ² is daily. Divide the annual rate by the number of days stated in the question.
• Using standard deviation instead of variance in the Miller-Orr formula. Fix: Square the standard deviation first. If the question gives variance, use it as it is.
• Treating lock box and concentration banking as the same thing. Fix: Lock box uses a post office box handled by a bank. Concentration banking uses regional collection accounts whose funds are moved to a central account.
• Multiplying cash released by the rate but forgetting the scheme's cost. Fix: Always compute net benefit as annual benefit minus annual cost, then decide.

Exam tips

• Expect 4 to 6 mark theory questions such as 'explain functions' or 'differentiate'. Prepare a standard list of 6 functions.
• In MCQs, check whether the activity involves cash, funding, investment or financial risk. If it does, it is likely a treasury function.
• For difference questions, use a clear two-column layout with at least three bases.
• Write the definition even in a case question. It earns easy marks.
• Link the topic to cash management and working capital in longer answers to show connected understanding.
• Write each motive as a bold heading with a one-line meaning and an example. This earns separate marks.
• In case-study MCQs, find the trigger word (routine, emergency, opportunity) and match it to the motive.
• When asked for objectives, give both liquidity and cost control and mention the trade-off.